The architecture is not the force

How a business friendly government has failed to arrest the slide in private investment

It may appear that the recent hullabaloo over GDP (gross domestic product) growth in the past decade has cast a shadow over assessment of the economy’s progress since 2014, but it is not so. There exists enough information for this as GDP is not the sole indicator on which one needs to rely in such an exercise. Arguably, investment is another, mainly private investment, for governments can always raise their capital outlay ignoring the calculus of profitability.

The profit-economy link

For a private investor, on the other hand, financial commitments are based closely on anticipated profit. The expectation of profit is itself tied to the expected state of the economy. As much of the future is uncertain, some part of its expectation is likely to be based on current trends. Thus, private investment is tied both to the present state of the economy and its anticipated vigour. For a government interested in invigorating the economy, then, it is essential to inspire confidence in the private investor. The investment meant here is the expenditure on productive capacity as opposed to buying shares or even durable goods in secondary markets.

Private investment in relation to output has in most years since been lower than what it was in 2014. This may come as a surprise to some as the government of Narendra Modi had appeared a business friendly one. While noting the slide in private investment, two points may be made. First, the private sector comprises two segments, the corporate and the unincorporated, termed household, in Indian national accounts. Since 2014, after initially declining private corporate investment has shown a mild rise while household investment has fallen sharply. The overall effect has been downward. This despite the pro-business reputation of this government and the strong and repeated communication of the Prime Minister that it would support those who ‘Make in India’. Clearly this talk has not been enough to convince private investors, who probably find insufficient dynamism in the economy today and are unsure of the likely impact of the government’s policies on its future. The most business friendly government at the Centre in recent times has not had success in turning around a slide in private investment. This is the second point to note.

While ‘adventurist’ has been pronounced as a verdict on the economic policy since 2014, a purely economic explanation is at hand. The government may have mistaken the architecture for the force. For an economy, by architecture we would mean the framework within which activity takes place while force is the ebb and flow of the demand for and supply of goods.

Elements to the architecture

It is possible to see four elements of the architecture as visualised by the Modi government: the presence of foreign direct investment (FDI), a digital payments network, a streamlined indirect tax regime and less government. The government has had some success in moving the economy towards such an architecture. Almost the first significant economic move of the Prime Minister was to have met American CEOs while in New York in 2014. This has been followed by an increase in FDI to record levels since. But the fact remains that FDI is not a large part of total capital formation in India, and, therefore, even at the heightened level cannot really make too much of a difference. Also, FDI into India has generally flowed to sectors with a lower multiplier effect on output. Then came the demonetisation, initially spoken of as a ‘surgical strike’ on black money hoards but subsequently rationalised as nudging Indians towards adopting digital payment. The inevitable formalisation of the economy was to lead to more tax revenue for the government, enabling greater spending on infrastructure.

Next came the launching of the Goods and Services Tax (GST). The government cannot claim all the credit for this desirable move, for a restructuring of the indirect tax regime has been on the books, if not in the works, since the 1970s and there has been a high degree of participation of the States in its launching. However, in the haste to appear as reforming, the Central government may have overlooked the need for a strong information technology (IT) network, education of the taxpayer and a facilitating tax bureaucracy. The States may well have agreed to the date of launching as they were to be compensated for any loss of revenues. Finally, the counterpart of the election slogan, ‘minimum government’, has materialised in the form of a steadily declining share of public expenditure in the economy. So the government has been able to achieve the architecture that it aspired to. Extensions of it have reached the two arms of macroeconomic policy. First, there was the move to what is referred to as a ‘modern monetary policy framework’. This has meant that the sole objective of monetary policy would be inflation control. That there can be collateral damage to growth is considered inconsequential. Fiscal policy has been guided by ‘fiscal consolidation’ or a focus on deficit reduction. That this could be achieved by varying combinations of the revenue deficit and public investment appears not to have been considered.

A significant part of the promise of demonetisation and the introduction of the GST, namely higher public revenues from formalisation, has not materialised. In fact, there are reports of the possibility of the fiscal deficit target for this year being breached due to lower than expected indirect tax revenues. On the other, it is clear that the dip in the growth rate in 2016-17 was due to demonetisation. The economy had slowed in the very next quarter after it was implemented, with the manufacturing sector actually contracting. As for the macroeconomic policy that has been pursued since 2014, it has acted as a pincer movement on aggregate demand. Rising interest rates, presumably needed to ensure that the inflation target is met, and fiscal consolidation are sure to have crimped it. Apart from any immediate effect of lowering the fiscal deficit, the route it has taken may also have consequences for long-term growth. In 2017-18, Central government capital expenditure was lowered in real terms. A less recognised aspect of the modern monetary policy framework is that the real exchange rate has appreciated since its adoption. This could only have reduced the demand for India’s exports, further lowering aggregate demand and holding back private investment.

Unimaginative maxim

The economic policies of the Modi government have failed to enthuse the private sector. Private investment has continued to slide during its tenure. A most natural thing for the government to have done would have been to raise substantially its own investment. This it has not done. A rising public investment can nudge the private sector to follow suit as the latter perceives superior growth prospects raising the latter’s expectation of profits. Actually, “minimum government” is an unimaginative maxim for governing the economy.

The government must respond imaginatively to the emergent economic situation. In the context, to the extent that sliding private investment reflects declining profit expectations, economic policy must anchor profit expectations. Under India’s new monetary policy framework, institutionalised by this government, the monetary authority aims to anchor inflationary expectations but this by itself can do little to convince firms of improved profits in the future. That this is how the economy works may be surmised from the fact that inflation has trended down steadily since even before 2014 but that has not revived private investment.

Cutting through the smog

Practical interventions exist to tackle the issue of stubble burning

Incidents of stubble burning — following the harvest of paddy crop in Punjab and Haryana — cannot be averted by imposing fines, or giving notice or giving farmers capital subsidy. Instead, the issue requires long-term vision and strategic policy interventions.

Air pollution is a worry especially in north India. Stubble burning is said to be a key factor behind the formation of a dense cover of smog in this part of India though its contribution is less than 20%. Farmers are held responsible for the crisis but what is at fault are the flawed and short-sighted policies of the Central and State governments.

Policy of rotation

In the 1960s, wheat-paddy crop rotation was encouraged in Punjab and Haryana to make India self-sufficient in foodgrain production. Large public investments in irrigation and adoption of high yielding varieties under the Green Revolution helped achieve the goal and make the nation food secure. However, the negative externalities in terms of land degradation, adverse soil health due to overuse of fertilizers and pesticides, and plummeting water tables have surfaced.

The share of paddy (rice) in the gross cropped area in Punjab has increased from 6.8% in 1966-67 to almost 36.4 % in recent years, while it has increased from 4.97% to 20% in Haryana. The increase has undisputedly been at the cost of the area under maize, cotton, oilseeds and sugarcane. The policy of minimum support price for crops, in tandem with their assured procurement and input subsidy, have left farmers with no option but to follow this rotation. Besides, Punjab enacted a water conservation law in 2009 which mandates paddy sowing within a notified period (some time in June instead of the earlier practice in May). A shorter period of sowing days prohibits transplantation before a notified date, which in turn limits the window available for harvesting paddy to between 15 and 20 days. As a result, farmers who are pressed for time to sow wheat and maintain crop yield find stubble burning to be an easy and low-cost solution.

One possibility to curtail the practice is to ensure that the government encourages crop diversification towards less water-intensive crops by extending price incentives and better marketing facilities. In some districts, farmers have started growing kinnow fruit but are often dissuaded due to high price volatility and the absence of a market. The policy of a ‘price deficiency system’ — as initiated in Haryana and Madhya Pradesh — should be adopted to strengthen the production and marketing of alternative crops. Another option is to replicate the Telangana model of providing farmers an investment support of ₹8,000 per acre each year and withdraw price-based support.

Punjab faces another serious problem: labour shortage. In the Agricultural Census 2011, average land-holding size has increased from 2.89 hectares in 1970-71 to 3.77 hectares in 2010-11 — higher than the national average of 1.5 hectares. Paucity of labour for various farm operations is substituted by machines for which the government extends financial support.

A road map

Farmers have already made investments in seed drill machines for sowing wheat after paddy harvest. Increasing pressure by the government on farmers to purchase the ‘happy seeder’ to abate stubble burning adds to the cost incurred by farmers. Even if the machine is available at a subsidised rate of nearly ₹1 lakh, it would remain idle the whole year and become a liability in terms of maintenance. It is not a viable option for small and marginal farmers who hardly earn ₹60,000 in a year. Imposing a fine for burning straw is again unreasonable. The fine imposed per hectare is much lower than the cost incurred on a ‘happy seeder’.

A feasible remedy could lie in the setting up of custom hiring centres or inviting companies to make investments for rental purposes. If the state provides an app-based support system, to rent out tractors and farm implements and earn additional income — there are examples of this in Nigeria and also in Rajasthan, Madhya Pradesh, Gujarat, Uttar Pradesh and Bihar — it would be akin to the ‘Uberisation of agriculture’. It would avoid stubble burning and at the same time make farming more mechanised, cost effective and a source of employment.

Another far-sighted approach could be in effective use of paddy straw. Unlike wheat residue, which is used as fodder, paddy straw is non-palatable to animals as it has high silica content. Farmers, who have already been sensitised to refrain from burning residue, should be given options such as biomass generation. Now, hardly 20% of straw is managed through biomass power plants, paper and cardboard mills. The government should use geospatial techniques to identify areas where stubble burning is severe and encourage installation of biomass plants at such locations. This will not only reduce transportation costs for the firm or village entrepreneurs but also help the government achieve its target of generating 227GW based on renewable energy sources by 2022. Farmers can also be incentivised to sell the residual for additional income. The residual has uses, such as in paper, cardboard and packing material making and also hydroseeding (defiberised rice straw can be used in hydroseeding for erosion control).

Seema Bathla and Ravi Kiran are Professor and Research Scholar, respectively, at the Centre for the Study of Regional Development, Jawaharlal Nehru University, New Delhi

‘Our calorie-oriented approach to agriculture is no longer sustainable’

The Principal Economic Adviser to the Ministry of Finance on rural distress, the GDP back series data, NPAs, and slow GDP growth in the second quarter of this FY

The government has come under a lot of criticism over its estimates for economic growth during the United Progressive Alliance years and for the slowdown in GDP growth in the second quarter of this financial year. Sanjeev Sanyal, Principal Economic Adviser to the Ministry of Finance, argues that even though the GDP back series lowered growth for previous years, the growth rates were still “decent” if seen in isolation. The real concern, he says, was that macro stability indicators fared much worse during that time. Excerpts from an interview on the non-performing assets (NPA) situation, the IL&FS crisis, and meeting the fiscal deficit target this year:

The question of the day is to do with the GDP back series data. What are your key takeaways from the new data?

We shifted the calculations to a new 2011-12 base in 2015. This is done periodically to realign national accounts to the changing structure of the economy. All new GDP data are done on this basis but we needed to extend it backwards to provide a longer series. This is what was announced last week. The CSO (Central Statistics Office) is a professional body and the methodology is as per internationally accepted standards.

Some insinuations have been made that these revisions are politically motivated. In fact, when this series was originally introduced in 2015, one of the results was that the growth rates for 2012-13 and 2013-14 were revised up very significantly. In the case of 2012-13, it was revised up significantly [twice], from 4.7% to 5.1%, and then further to 5.5%. So, the new series increased the growth rates for certain years of the previous government and was welcomed. If the same methodology now lowers the growth rates of earlier years, that is how it is.

Do the new numbers change the way we look at the economy in the recent past? Did we never really hit a high-growth phase of over 9%?

The revised back series growth rates would still count as decent growth rates in isolation. The real issue, I would argue, were the macroeconomic stability numbers. There was a spike in inflation to double digits and a large and irresponsible expansion in credit which later led to banking NPAs. Current account and fiscal deficits widened sharply. Thus, India was marked out as one of the ‘Fragile Five’. So, while the new GDP growth numbers for 2005-06 to 2011-12 are somewhat weaker than previously calculated, the real problem was in macro stability.

What’s your outlook going forward on the NPA situation? Do you think we need one more round of recapitalisation, more than what was already promised?

We introduced, in the last few years, much more stringent recognition norms for NPAs and capital requirements for banks. Recognition is now done strictly, and NPAs have been mostly taken into account. We are using the Insolvency and Bankruptcy Code to resolve/liquidate/auction NPAs. In this way, we are making our way through the old problem loans. Meanwhile, as a part of a revival plan, ₹2.11 lakh crore was earmarked for recapitalising banks. This is being deployed in a calibrated fashion. More will be made available if necessary.

What’s the lesson on regulation in light of the IL&FS crisis in the NBFC (non banking financial company) sector?

The NBFC sector is now a much more significant part of the economy than it used to be. We need to pay attention to regulating it and, in particular, pay special attention to larger institutions by taking into account their systemic importance, their asset-liability mismatch, and so on.

The other lesson is that the credit market needs to be kept flowing during periods of stress. Otherwise it freezes up and causes a liquidity contagion of its own. In India, everybody pays attention only to the stock market whereas it is the credit market that is at the heart of the financial system.

With the rise of the NBFC sector, aren’t banks less important? Will there be a problem now with NBFCs slowing?

When we cleaned up the banks and slowed their expansion, the space was taken up by NBFCs. But now NBFCs themselves will go through a period of consolidation. The immediate credit market roll-over problems have been eased but many of them will now have slower growth. Parts of the economy, particularly some of the SMEs (small and medium-sized enterprises), have experienced a credit squeeze. So, we need to make sure that adequate credit reaches them. The good news is that mainstream bank credit has revived and is growing at over 14% year-on-year.

We also have the problem that real interest rates are very high, especially for SMEs. If you are borrowing at 12% (not uncommon for SMEs), when inflation is at 8%, that’s one thing. But it’s quite another when inflation is at less than 4%. A real rate of 800bps (basis points) is very high by any standards. The Monetary Policy Committee (MPC) has brought down structural inflation by some 500 basis points. That’s a good thing, but we now need to take step two, which is to structurally lower interest rates in real terms so that it is compatible with the new level of inflation.

Economists often ignore the long-term, second-order effect of high interest rates. High interest rates may lead to low inflation in the short to medium term. In the long term, however, high interest rates have a supply side impact such that capacities are not created, infrastructure is not built, and the economy gets indebted. The riskiness of the financial system increases, and fiscal burden rises. Thus, higher interest rates in the long run actually lead to higher inflation. This is not a case for arbitrarily bringing down interest rates suddenly. But once we have anchored lower inflation, there is a case for systematically lowering real interest rates.

What is your take on the government meeting its fiscal deficit target this year?

This government is committed to fiscal responsibility. The fact that we are debating a fiscal deficit of 3.3% or 3.5% of GDP is in contrast to when we used to debate 5% or 6%. It is true that disinvestment of Air India is delayed. Monthly GST (Goods and Services Tax) collections are a bit lower than the target rate, but remember we are getting higher collections in others areas — customs collections will benefit from a weaker rupee; direct tax collections have improved from better compliance. Even in disinvestment, we have raised much more through recent ETFs (exchange traded funds) than people realise.

In light of the ongoing tussle between the Reserve Bank of India (RBI) and the Finance Ministry, what is your take on central bank autonomy?

Every Finance Ministry and central bank in the world debates these issues. The question is, what is the institutionalised way of doing it? We value RBI autonomy, but this autonomy is within the framework of the RBI Act. Greater autonomy also means greater accountability. To whom is the RBI accountable? As per the RBI Act, it is accountable to its Board. Just as we institutionalised monetary policy decisions by creating the MPC, in the same way we have institutionalised our relationship with the key regulator through its Board. In fact, as a result of this precedent, we have effectively institutionalised our relationship with every regulator.

Why has GDP growth slowed to 7.1% year-on-year in the July-September quarter?

Part of the decline in the year-on-year growth rate from 8.2% to 7.1% is due to a higher statistical base. This was anticipated. However, part of the decline is due to factors such as the spike in energy prices, disruptions in NBFC credit and the impact of global liquidity tightening. These factors had an impact from end-August to end-October, but have substantially abated since. Latest bank credit data suggest that more funds are flowing to the commercial sector, albeit the net impact after the NBFC slowdown is unclear. Similarly, global oil prices have dropped and the U.S. Fed’s tightening cycle is likely to be less steep. Manufacturing PMI readings for November were also strong.

We have seen major reforms like the MPC, GST and the Insolvency and Bankruptcy Code in the last few years. What should we expect next?

The last 25 years of reform were about the withdrawal of the Indian state from things it should not do and creating transparent policy frameworks for the private sector. This is why the words ‘reform’ and ‘liberalisation’ are often used interchangeably. This is still unfinished business but we have made substantial progress over several governments. The next 25 years of reform, however, must focus on getting the state to deliver on the things it should do. This will mean reforming the legal system, streamlining the administrative system, delivery of municipal services, and so on. This will require thinking about reforms in a very different way.

What is the way forward to tackle the various issues facing our agriculture sector and the farmers?

The immediate strategy is to make sure our MSP procurements go through and that reasonable incomes reach farmers. But there is a longer-term debate to be had about our agricultural policy as a whole. In this context we have to look at the fact that our agricultural policy framework was set up in the 1960s in a period of scarcity, so it is aimed at producing ever more calories. Our population growth has radically declined and is now growing at less than 1%. In such an environment, our calorie-oriented approach to agriculture is no longer sustainable. We need to rethink farm policy: how to produce more proteins, more cash crops, more investment in cold-chains, preservation of indigenous varieties, and so on.

Shift to low carbon

India’s stakes in a low carbon world economy are among the highest as it is on the front line of climate disasters

Both rich and poor countries have faced extensive damage from storms and heatwaves this year. As climate representatives meet in Poland for the Conference of the Parties 24, the crucial question is whether carbon emissions will be reined in to avert further damage due to climate change.

In India, rains, floods and landslides in Kerala have killed 373 people since May 30. Uttar Pradesh, Karnataka and Assam were battered by floods this year, as was Chennai in 2015. Meanwhile, Delhi, Rajasthan, Andhra Pradesh, and Telangana, among other States, experienced heatwaves.

Greenhouse gas emissions, of which carbon dioxide is the biggest component, make the earth warmer and lead to more heatwaves. A study in the journal Scientific Reports found that the decadal mean of daily maximum temperature for April and May in the 2010s is 40-42°C over large parts of India. Warmer air holds more moisture, which results in more intense rainfall and provides more energy for storms. Climate scientists attribute the rising trends in flooding and heatwaves to human-induced climate change.

In the absence of a shift to a low carbon economy worldwide, the average temperature could rise by more than 2°C by the end of this century. Hotter, longer summers and excessive rainfall in some areas and droughts in others will damage crops. Warm coastal waters will turn unsuitable for certain species of fish.

Adapting to a changing climate is one part of the agenda. Japan has invested a lot of money on coastal defences. It has built the world’s largest underground flood water diversion facility. But with a coastline of about 7,500 km, most of which is low-lying, India cannot make such colossal investments. Better early warnings and timely evacuations have had huge pay-offs, the most striking example being the massive relocation of people from the coasts of Andhra Pradesh and Odisha before Cyclone Phailin struck those areas.

But adaptation will not suffice unless mitigation takes central stage among the world’s leading emitters, including India. The country has committed to cuts in carbon emissions consistent with a 2˚C temperature rise. But plans to build new coal-fired power plants need to be abandoned and replaced with a massive ramp-up of wind and solar power. India’s stakes in a low carbon world economy are among the highest as it is on the front line of climate disasters and is also a leading contributor to greenhouse gas emissions. Apart from taking steps to adapt to climate change, India’s voice in decarbonising the world economy is vital.

The writer is Visiting Professor, Asian Institute of Management, and author of ‘Climate Change and Natural Disasters’.